THE GREEK CRISIS: BE FLEXIBLE ON DEBT, BUT INTRANSIGENT ON REFORMS

Greece’s voters have spoken; it is now time to act quickly to prevent a Grexit, and it will require sacrifice on all sides. We can better understand what is the proper strategy for Greece – and the EU – if we remind ourselves of some basic facts:

Until 2010 Greece had accumulated extreme fiscal and macroeconomic imbalances while maintaining an institutional regime which favoured the public sector and rent-seeking to the detriment of honest private activity.

These policies were facilitated by massive inflows of cheap credit from more-developed countries of the euro area, which in turn were due to some policy failures at the level of the euro area, that produced an extreme suppression of the credit spreads in this area.

– In response to the crisis that emerged in 2010, Greece has found itself under the supervision of the Troika (the EU Commission, the ECB, and the IMF). There has been a sharp divergence between the agreed and the implemented programs, and the latter has had such a time structure that it has sharply reduced the inherited imbalances. But there have been high costs in the form of a deep cumulative decline in GDP (over 25% between 2010 and 2014) and a sharp increase in unemployment. The implemented policies relied first on the tax increases. They delayed reforms on the spending side as well as the structural reforms, which were absolutely essential to improve conditions for business. This was in sharp contrast to the policies implemented in the Baltics and in Ireland, where rebalancing of the economy after the acute boom bust episodes was achieved at much lower costs to GDP and employment. It had been the nature of the implemented programme in Greece and not ”austerity” (a bad word) which is to blame for the especially high costs of economic rebalancing in Greece

– However, progress has been made. A deep fiscal adjustment has been achieved in Greece and a huge balance of payment deficit has been eliminated, too. Exports have started to grow, which is essential for such a small country. Some substantial structural reforms have been introduced (eg. the certain deregulation of the labour market). As a result, the economy has started to recover and the GDP growth in 2015 was forecast to reach almost 3% (EC forecast, Nov. 2014). If the implemented reforms are not reversed and other necessary improvements for the private sector and job creation are introduced (especially reforms of the bloated state structures and the privatisation of the state sector) Greece can be a surprisingly successful economy. This conclusion is supported by the ample experience of reforms in the initially heavily distorted economies, including those in Poland. However, the victory of the far-left Syriza party appears to put those reforms in question.

The parliamentary elections increased the political risk, which the financial markets have been reacting to as expected. Every strategy available to the EU main actors is risky, but regardless of who governs Greece, we believe these steps should be taken: First, be absolutely determined on structural reforms. They are essential for the Greece’s economic growth, and they are not painful for the society at large but to some statist vested interests in this country. Besides, giving up on reforms could send a very bad signal to the other problem countries (Portugal, Spain, Italy, France) where they are also key to growth.

Second, if necessary be ready to show some flexibility on further restructuring the official debt (but not on a new bailout or debt forgiveness as Syriza leader Alexis Tsipras is demanding). However, this should be considered only in conjunction with the intransigence on reforms. This potential concession should reward reforms and not economic populism.

Third, while not seeking the Grexit, be ready for it, if the Greek authorities do not deliver on structural reforms. The main benefit of the Grexit option is that, like a sword of Damocles, it could increase discipline in the euro area and raise the vigilance of the financial markets. It is the nuclear option we all hope does not happen, if all sides can show appropriate flexibility while addressing the voter anger.